New Zealand Dollar Seen on Road to Recovery as Dairy Prices Bottom and Political Risk Fades

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Political uncertainty is fading and milk prices now appear to have bottomed, which could lift NZD/USD to multi-year highs in 2018. But the Pound still looks set to rise further against the Kiwi currency.

The New Zealand Dollar won back previously lost ground from most of its G10 rivals overnight and during morning trading in London Thursday.

One strategist slates the move as a delayed reaction to Tuesday’s dairy auction. This saw milk prices rise at a faster (4.9%) pace than was expected, leading to speculation that the trend of falling prices may have come to an end.

“NZD was the big winner overnight. There doesn’t seem to be any particular news to move the market, so I would guess that this was just the delayed reaction to the better-than-expected milk auction, as I mentioned yesterday,” notes Marshall Gittler, chief strategist at ACLS Global.

“I don’t expect this strength to continue today however, as it pretty much reverses the previous losses. Plus I expect some buying of AUD/NZD.”

However, another strategist is flagging a broader theme of fading political risk and continued economic stability, alongside better milk prices, as grounds to think the Kiwi currency can do well in the months ahead.

Milk prices matter to the New Zealand Dollar because powdered milk is the nation’s largest export.

“While a weak USD environment partly explains the extensive rally in NZD/USD beyond 0.72, one cannot neglect the positive local story that is starting to transpire,” says Viraj Patel, a strategist at ING Group in London.

“Lower political/policy risks, resilience in the New Zealand economy and signs of a bottoming out in dairy prices – all spell good news for the kiwi in the near term.”

The NZD/USD rate was quoted 0.29% higher at 0.7292 by mid-morning Thursday while the Pound-to-New-Zealand-Dollar rate was quoted 0.08% lower at 1.8995.

Above: NZD/USD rate shown at weekly intervals.

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New Zealand's currency has gained more than 3% against the greenback in January, which makes it the best performing currency in the G10 for 2018. It has also risen by 4.3% in the last month.

“Though the policy uncertainty of a Labour-NZ First coalition led to a NZD sell-off in 2017, the currency has since stabilised as we had expected – with the dust settling on the new government,” Patel adds.

Patel and the ING Group team have upgraded their 1 month and 3 month New Zealand Dollar forecasts and reiterated their bullish projections for the currency’s performance over the next 6 months and out till year-end.

These see the NZD/USD rate still trading around 0.7200 next month before rising to 0.7400 in 3 months time. By year-end, ING forecasts the NZD will rise to 0.7800.

The 0.7800 year-end forecast represents the highest level for the NZD/USD rate since January 2015, when the commodity price collapse and fears of a slowdown in China really gathered pace, and implies a 2018 return of 9.9% for the exchange rate.

If the New Zealand Dollar were to rise to 0.7800 then, assuming the Pound-to-Dollar rate is able to hold its current level of 1.3900, the Pound-to-New-Zealand-Dollar rate would fall to 1.7820 by year end.

However, Patel and the ING team forecast the Pound-to-Dollar rate will rise to 1.5300 by year-end which, when taken together with the NZD/USD forecast, should be enough to push the Pound-to-New-Zealand-Dollar rate up to 1.9615.

Above: Pound-to-New-Zealand-Dollar rate shown at weekly intervals.

If realised, the NZD/USD performance would mark a complete reversal of fortunes for the New Zealand currency which, just two months ago, was under severe pressure as the 2017 general election came to a head and the result of a hung parliament became clear.

Still, despite broad economic stability, not everybody is as optimistic as the team at ING. Bank of New Zealand forecasters reiterated their bearish outlook for the Kiwi currency just this week.

“Our fundamental view on the NZD hasn’t changed. From the current level the balance of risk is skewed to the downside for the NZD, notwithstanding the possibility of a further near-term short squeeze,” says Craig Ebert, an economist at BNZ, a division of National Australia Bank.

“Ultimately we see the global policy rate environment as negative for the NZD to the extent that rising global rates dent the outlook for global growth and risk appetite.“

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Inflation expectations are important for currency markets because the RBNZ can only be expected to raise interest rates after inflation has made a sustainable return into the higher end of the 1% to 3% target band.

“We don’t foresee an OCR hike until late-2019. If anything, we would put the odds of an OCR reduction this year as slightly higher than the odds of a hike, although a large shock would be required to generate either,” - Westpac.

Fourth-quarter unemployment data comes ahead of the latest interest rate statement from the Reserve Bank of New Zealand, which could yield a hawkish change in the central bank's language, according to one strategist.